Taxation of carried interest holders in a private equity fund
Produced in partnership with Emily Clark of Travers Smith
Taxation of carried interest holders in a private equity fund

The following Tax guidance note Produced in partnership with Emily Clark of Travers Smith provides comprehensive and up to date legal information covering:

  • Taxation of carried interest holders in a private equity fund
  • Allocation and distribution of carried interest
  • The carried interest partner
  • Taxation of carried interest returns—ordinary tax principles
  • Sharing in the fund’s profits—base cost and capital gains
  • Abolition of base cost shift
  • Income-based carried interest

Carried interest (or carry) is a subordinated, contingent right to share in the 'super-profit' of a private equity fund. It is typically held by members of the private equity manager's management team and enables them to share in the profits, gains and losses of the fund once investors have received back an amount equal to their original investment, plus an additional return on their capital. It is popular with fund investors because the team's success is aligned with the success of the fund.

Both the fund and the carried interest vehicle (the carried interest partner) are typically structured as tax transparent limited partnerships. For a discussion of why limited partnerships have become the fund vehicle of choice, see Practice Note: Onshore private equity fund structure: the fund. This transparency means that the holders of the carried interest are taxed (once the carried interest kicks in) as if they owned their share of the fund's underlying shares and securities directly. If the fund profits take the form of interest income, the carried interest holders are taxed on interest. If the fund realises a capital gain, the carried interest holders are subject to capital gain tax rates.

However, this principle of tax transparency (of looking through the partnerships to the underlying source of the profits) has been undermined in relation to carried interest firstly by